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Thursday, March 1, 2012

As of my first post here, I thought starting with the basics would be the best way to express the philosophy of value investing. I suppose the question suggested on the headline would be one of the first questions in what tangles the subject.

For most of the population, price is a synonym for value. Although for value investors this is not valid. Merriam Webster’s dictionary defines both price and value. Below we find the quotes:

price: “the amount of money given or set as consideration for the sale of a specified thing” (source: Merriam Webster)

By those definitions we may infer price isn’t the same as value. Why? Notice the definition of value has the word fair in its meaning, while price has not. Price in the financial markets is the number of currency units you pay for a share of a company and you can see it bleeping on your screen all day long. But the question the value investor asks himself everyday is: Does this company is worth what I am paying for its shares? Does it worth more than that? Or less? Notice worth is the keyword here.

For uncountable times “Mr. Market” – as Ben Graham used to name the financial markets – tells us what price he is charging you for a share of a specific company. The job of the value investor is question “Mr. Market” if he is on sale. I would call a value investor a value hunter. Putting this concept in a logical way, we have:

Situation 1: If (price < value) -> success

Situation 2: If (price >= value) -> failure

Putting it as Mr. Warren Buffet did in his last shareholder's letter:

"In my early days I, too, rejoyced when the market rose. The I read Chapter Eight of Ben Graham's The Intelligent Investor, the capter dealing with how investors view fluctuations in stock prices. Immediately the scales fell from my eyes, and low prices became my friend."

Quoting Mr. Seth Klarman in his last piece of work:

"Value investors know - although efficient market believers fail to comprehend - that the underlying value of a security is distinguishable from its daily market price, which is set by the whim of buyers and sellers, as are the prices of rare art and other collectibles."

Thus value investors have to find hidden treasuries in the financial markets so he can perform well his job. It is not an easy task, since the number of bargain hunters has been growing along time. Remember Ben Graham closed his fund during the fifties after a remarkable track record because, among other reasons, there were no more plenty of bargains (you may read net nets – I shall write about it in a later post) in the markets. Hopefully we will keep finding value on a constant basis.